Tuesday, March 16, 2010

Coming Crisis in the Debt Markets?

Today's New York Times carries a story which claims that the bond market is headed for a crisis starting in 2012.

According to the article, the looming problem stems from the huge amounts of maturing debt that will need to be refinanced in a couple of years. Many of these issues are junk bonds, which came to market between 2005 and 2007 carrying maturities of 5 to 7 years.

On top of these maturities, of course, will be the huge capital demands of the US government.

I love the Times - it is easily my favorite newspaper - but I think they are wrong on this one.

All of the debt that is outstanding is, by definition, held by some investor or institution. If they hold a bond that matures, what are they going to do with the capital? Most likely, they will be looking at buying another corporate bond issue, which means in effect that the maturing debt creates its own demand for new debt issues (provided that it is priced appropriately, of course).

The same could be said for the huge needs for funds that will be coming from the federal government. True, the government will need to raise capital to repay investors for the Treasurys that will be maturing, but what other alternatives are available to the bond holders?

I could go on, but consider this: In 2000, at the end of the Clinton administration, the federal budget was essentially balanced. Ten year Treasury notes were yielding around 6.5%. Now, 10 years later, the federal deficit is $12 trillion, and deficits will be the norm for years to come - yet 10-year Treasury notes now yield 3.7%.

Supply in-and-of-itself does not force yields higher. There are too many other forces in play that determine the level of interest rates.

Here's an excerpt from the article, with the full link below:

March 15, 2010

Corporate Debt Coming Due May Squeeze Credit

When the Mayans envisioned the world coming to an end in 2012 — at least in the Hollywood telling — they didn’t count junk bonds among the perils that would lead to worldwide disaster.

Maybe they should have, because 2012 also is the beginning of a three-year period in which more than $700 billion in risky, high-yield corporate debt begins to come due, an extraordinary surge that some analysts fear could overload the debt markets.

With huge bills about to hit corporations and the federal government around the same time, the worry is that some companies will have trouble getting new loans, spurring defaults and a wave of bankruptcies.

The United States government alone will need to borrow nearly $2 trillion in 2012, to bridge the projected budget deficit for that year and to refinance existing debt.

Indeed, worries about the growth of national, or sovereign, debt prompted Moody’s Investors Service to warn on Monday that the United States and other Western nations were moving “substantially” closer to losing their top-notch Aaa credit ratings.